Thursday, January 17, 2013

Utterly immeasurable...

In the world of investing there's forever a premium on predicting. Folks want to know the future. I can't tell you how many times clients have asked me to make the necessary adjustments to their portfolios should I see something coming (like I have to be asked to do that). The thing is, no one ever sees something coming. People make un(street)educated guesses based on some set of assumptions regarding items such as debt ceilings, sequesters, the balance of power in Washington, earnings outlooks, existing home sales, international conflicts, capacity utilization, retail sales, beige books, multiples, profit margins, free cash flow, takeovers, weather patterns, Elliot waves, Fibonacci curves, I could fill a book. I say "un(street)educated", because any undeluded individual with a little street experience knows you can't time the market. Ah but someone as connected as me, after nearly thirty years in the trenches, would surely have enough experience under his belt to at least anticipate how the market will react to a given set of circumstances, wouldn't you think?

How many times have you felt reasonably certain about the outcome of an impending sporting event? Perhaps the teams met two months earlier---same players, same venue, same time of day even---and Team A handled Team B while barely breaking a sweat. Pretty safe bet (you'd think), given the known set of circumstances, that Team A will prevail once again. Then, by some miracle, Team B takes Team A out to the woodshed. What the heck happened? Did the losing point guard party too hard the night before? Was the center low on blood sugar? Did the coach have an argument with his wife just before tip off, setting off a mixture of adrenalin and hormones that impaired his play-calling ability?

So if outcomes are uncertain, even when we know the players, imagine making a prediction as to the near-term direction of markets and the economy---where the players (the buyers and sellers of securities, and the buyers and sellers of goods and services) number in the billions, and the variables that would influence their actions are utterly immeasurable.And my the challenges facing those who would attempt to steer the economy*.

So what's an investor to do? Simply be an investor (not a trader), diversify globally and think long-term.

The human being observes a bird in flight and then analogizes his – the human’s – limbs and muscle movements to what he supposes, from his observations, are those of the bird. But the human is too easily misled into thinking that he can easily-enough mimic the bird’s body and movements and, thereby, achieve flight.

Obviously, no human can do so. Such attempts as there have been by man to strap on wings, flap, and fly invariably failed – sometimes catastrophically for the pretend Icaruses.

Attempts to centrally plan economies are very much like attempts to fly by dressing like and flapping like a bird: utterly futile because the most that can be observed of any successful economy are a handful of large details (“assembly lines,” “retail outlets”…..). The vast majority (99.99999999999…9 percent) of the details that must work reasonably well aren’t observed by the would-be central planner. What Hayek called “knowledge of the particular circumstances of time and place” – knowledge of details spread today across the globe and across billions of different human minds – is not incidental to the successful operation of a modern economy. Utilizing that knowledge – vast, deep, changing, incredibly fine-grained detailed knowledge – is the very key to a successful market economy.